In Praise of Deficit
* Article: In Praise of Deficit: Public Money for Sustainability and Social Justice Paper presented to AHE conference July 2015 Mary Mellor,
This paper is based on my forthcoming book Debt or Democracy: Public Money for Sustainability and Social Justice (Pluto). It will make the case that deficit, expressed as surplus public expenditure is essential for socially just and sustainable provisioning. Conventional notions of public money as public expenditure based on taxation of privately created wealth will be critiqued. Public money will be defined as the creation of public currency free of debt, and therefore free of the necessity to grow. It will be argued that both sovereign deficit and debt are misleading concepts and stem from neoliberal ‘handbag economics’ that sees the public sector as a dependent household. Through exploring two circuits of money, public and commercial, it will be argued that growth driven capitalist economies are dependent on the public creation of public money. The seeming dominance of the commercial circuit reflects the ‘Janus-faced’ role of central banks that supports both debt and growth. The alternative to debt is a money system based on surplus expenditure (deficit) that can enable social and public exchange of use-value rather than exchange of commodity value for profit.
The background to this paper reflects three crises: environment, inequality, money/ finance. I want to argue that money/finance is key to the other two. Concerns about climate change and other ecological problems are side-lined by the demand that economic growth, that is, profitability in money terms, must be maintained at all costs, or that remedial action cannot be afforded, that is, there is not sufficient money. The post war move towards greater equality has also been reversed by financialisation and the concentration on financial assets and financial speculation, all represented as growth in money terms. This is not to deny the importance of other economic factors, but money itself has been largely neglected in economic debate.
Instead, the politics of money should be seen as a key aspect of political economy. Environmental and social priorities are rejected by the claim that money is in short supply. However, there was no shortage of money when it came to the banking bailout. Money cannot essentially be in short supply as it is an entirely social construct.There is as much or as little as those who create, control and determine the distribution of money choose there to be. In this context I do not distinguish between notes and coins and bank credit in the definition of money as both create the supply of public currency. I want to argue that the financial crisis must be seen as a crisis for money, or more precisely, a crisis of the privatisation of the supply of the public currency. What the crisis reveals is the key role of publicly created money in sustaining private finance. Yet, the ideology of what I describe as ‘handbag economics’, claims that the 1 public sector has no right to the money that it, itself, creates. Publicly created money must only be used to support the privatised creation of the public currency as debt. There is quantitative easing for the financial sector, but not the people.
Worse, the people are punished through austerity for the deficits and public debts created by the crash. If sustainability and social justice are to be achieved, the privatisation of the public currency needs to be challenged. Public money must be a public resource that addresses democratically determined priorities (Mellor 2010). The 2007-8 crisis was not just a crisis of banking and finance but a crisis of the supply of public currency. The major fear that triggered the vast creation of public currency by public authorities was that the ATM machines would dry up. Certainly banks and financial institutions were insolvent as well as illiquid, but for the public the most immediate sign would be that there would physically be no money. However, the monetary authorities did not get the printing presses going, there was no time. It would take months, if not years, to produce enough banknotes to ‘back’ bank deposits. Also there was no other representation of value such as gold, which in any case would be not sufficient, even if the link with gold had not long been abandoned (if it was ever effective anyway). States and central banks backed their banking systems with nothing but their authority. They said the money was there and people accepted it. States nationalised or bailed out banks, central banks made rock bottom loans they did not expect to get back, and attempted to ‘quantitatively ease’ the amount of money in circulation by buying up various forms of debt or investment. In all cases they used public money, that is money created and circulated by public monetary authorities. The newly issued public money did not originate outside of those authorities, it was not ‘made’ elsewhere. Conventional economics has a contradictory attitude to this public money-creating capacity. While public expenditure is seen as dependent upon the ‘wealth-creating’ sector (states must not ‘print money’), it is quite accepted that monetary authorities create money. This is even graced with the title of ‘high powered money’ or ‘base money’. However this is not considered to be public money in the sense that the public has any right to it. It is created as public currency, in the public’s name, but it is only to be circulated via the banking system. The one body that must not ‘print money’ is the public itself through its public (but not necessarily democratic) organ the state. The people and the state can only borrow money from the banking and financial sector which includes the central bank.
Neoliberalism has made this clear by deeming central banks, with their authority to create money, as independent of any democratic institutions. States themselves are just another borrower. When states stepped into to rescue their banking sectors, they overran their expenditure plans dramatically, that is, they went into deficit. This required ‘borrowing’ under which excess state expenditure was securitised by the central bank and sold on to financial investors. The public sector was then pilloried for being in debt and forced into austerity. I want to argue that public deficit and debt is not a ‘problem’. In fact, commercial monetary economies cannot function without a long run surplus of public expenditure (deficit) over tax extracted. They cannot exist without publicly created money, that is, money free of debt spent into circulation or public currency made available to exchange for bank loans. There is no truth in the claim that environmental or social justice solutions cannot be ‘afforded’. There is no 2 shortage of money. What does exist is a dominant ‘handbag economics’ that ignores the social and public history of money. It also does not acknowledge that bank accounts are as much public currency as notes and coin. There is nothing private about bank-created money. In the last resort it is a public liability. Why, then, is it ideologically and in practice, captured as a private, rather than a public, resource? In response to the crisis, monetary authorities offered an almost blanket guarantee of their public currency in whatever form it was held. Intangible promises were made to support intangible money. This raises the question of the nature of money itself (Ingham 2004). What kind of money was in crisis and what kind of money was rescuing it? The crisis is acknowledged as being a crisis of credit supply and toxic debt as banks threatened to fall down like a line of dominos. As Duncan argues, this failure of ‘creditism’, the growth of debt, was equivalent to the collapse in money supply in the 1930’s (2012: 32). In the run up to 2007-8, banks were not just issuing credit, they were issuing the public currency. This challenges the conventional nostrum that there are two different kinds of money, ‘real money’ (notes and coin, central bank reserves) and ‘credit money’ (bank accounts).
The Public Circuit of Money
One of the earliest proponents of a public conception of money was the German, Georg Knapp (1842-1926). Far from a market-oriented and privatised view of money, Knapp saw the state as central to the existence of money. In his major work The State Theory of Money (1905/1924) Knapp argues that money is not an economic phenomenon linked to the market; it is very much a public phenomenon: ‘money is a creature of law’ (1924:1). For this reason, he sees the study of the monetary system as a branch of political science and ‘the attempt to deduce it without the idea of a State ..(is)..absurd’ (1924:viii). It is states that establish the status of money forms such as coins, public currency notes or abstract notions such as the pound sterling. Keynes echoed Knapp’s view: ‘‘that money is peculiarly a creation of the state’ (1971:4) and claims it has been so for four thousand years.
While for conventional economics the first function of money is as a medium of commodity exchange, Knapp stresses money as a more general means of payment. Although money is used in market exchange, there are many situations in which payment does not relate to the market, such as fees, fines or taxes. In fact, Knapp sees public administrative payments as a better grounding for the status of money than general acceptance in trade: ‘the money of the state is not what is of compulsory general acceptance, but what is accepted at the public pay office’ (1924:vii). Knapp acknowledges that commodities of material value (such as precious metal) have been used in exchange, but he does not consider this to be money. In fact, money only comes into play when the actual form of payment has no intrinsic value: ‘money comes into being when the material is no longer the means of payment’ (1924:25). He goes on to argue that even where money is made of precious materials, ‘the soul of the currency is not in the material of the pieces, but in the legal ordinances that regulate their use’ (1924:2). He notes that the first question a trader will ask in a new country is, what is the nature of the currency? At the time that Knapp was writing, paper money was well established and he wanted to defend the view that ‘the much-derided inconvertible paper money is still money’ (1924:38). Knapp sees all forms of money as a chartal or token (chartal comes from the Latin for token).
Paper or other non-material money is not inferior to metal money, as both are part of an administrative monetary system: ‘Coins are stamped discs made of metal’ while ‘warrants are stamped discs of paper’ (1924:56). Knapp’s state theory of money has a very different view of the origin and nature of money from conventional economics. Money is created by the state as a convenience for society ‘the State….creates it’ (1924:39). Knapp sees it as 6 particularly beneficial to the taxpayer that the state creates the money that it later accepts in payment of tax as it ‘frees us from our debts to the state, for the state, when emitting it, acknowledges that, in receiving, it will accept this means of payment’ (1924:52). What Knapp is describing is a public circuit of money. Money is created and circulated through state expenditure and retrieved as tax. A public sector circuit reflects the long history of sovereign creation of money. Early coinage was created free of debt and spent, mainly on war or aggrandisement. The money was then left to circulate or demanded back as tax. When modern bank lending emerged, rulers combined public money creation and taxation with borrowing from the commercial money sector and the sources of public funding became intertwined. The public circuit is obscured because public expenditure is an ebb and flow of money. States do not wait to collect taxes before engaging in expenditure. It is only when outgoings and tax income are brought together in the accounts that the balance between them can be seen. The sequence of taxation and expenditure is therefore circular: taxes are spent and expenditure is taxed. Rather than seeing the circuit starting with tax to fund expenditure, expenditure can be seen as providing money to pay taxes.
The ‘chicken and egg’ nature of the public circuit creates confusion over the role of the central bank (or equivalent public authority such as the Treasury). The central bank/Treasury can be seen as lending money for public expenditure pending the receipt of taxes, or it can be seen as creating money for public expenditure that will be redeemed through taxation. If the public monetary authority behaves like a commercial bank, it will see this money as a loan to the state. Future taxation is then a fiscal matter of retrieving the money to repay the loan (with interest). If the monetary authority sees itself as a public agency, the public currency could be created debt free, and spent, pending possible future taxation. Depending on how the public money circuit is interpreted, the incoming tax can be seen as being drawn from activities in the private sector (based on commercial wealth-creation) or it can be seen as the state’s own expenditure being returned. Given that in modern economies there is both public and commercial creation of public currency, both are true. Both circuits can be seen as creating value by providing goods and services. While the commercial sector extracts its value as price on the market, the value of the public sector is judged by the quality of its provisioning. If the creation of public currency is not through the commercial sector, money does not have to be issued as debt. Unlike the banks, publicly created public currency doesn’t have to be commodified. It can be spent or allocated as a public resource without the need to be returned (with profit). However it is not wise to create unlimited amounts of money. The public money circuit is therefore completed not by repayment of debt, but payment of taxes or fees. Tax in this case is not a fiscal instrument as in the commercial money circuit (raising taxes from individuals, households and companies for the public sector to spend) but a monetary instrument, to retrieve money from circulation that could otherwise be inflationary. This creates a very different position for the taxpayer. Instead of ‘hardworking families’ paying out their ’hard-earned money’ in taxes, they can be seen as returning money that has done its work in creating public benefit (paying doctors, building bridges, environmental work, care for the elderly).The main difference between the 7 commercial and public circuits of money is that publicly created money may be issued as debt, but bank created money can only be issued as debt. While the former can be used for social purposes on a sustainable basis, the latter must demand growth and profitability. The former can spend more money than it seeks in return (surplus expenditure), the latter always wants to receive more money than it creates.
Recognising the public circuit of money puts deficit spending in a new light. Running a deficit does not need to put the public sector into the red. A deficit means that the public sector is spending more money than it is asking back in tax. How this is perceived depends on whether the source of money is seen as emerging from the public or commercial circuit of money. The role of the central bank is critical here. If the extra public expenditure is seen as being ‘borrowed’ from the central bank it will be sold on to the financial sector and added to the national debt. Seeing the central bank as exercising the sovereign prerogative to create money, would allow the additional money to circulate debt free. If the ‘deficit’ is not taxed, it can filter into the private sector and be a net gain to the economy as a whole. Quite the opposite occurs when there is the demand for the public sector to balance the books, or, worse, go into surplus. If the public sector takes more in tax and payments than it spends, it is extracting money from the economy. As Duncan argues ‘however much government spending is cut by, the economy simply contracts by that amount’ (2012:24). Far from being a problem, there needs to be a public deficit. Creation by public authorities of money that is not reclaimed is necessary, otherwise the privatised money supply will go into crisis, as a purely debt-based money supply is not sustainable. Rather than demanding an end to budget deficits, they should be seen as a key element of macroeconomic policy in creating financial stability (Arestis and Sawyer 2010). As Wray argues, ‘if government emits more in its payments than it redeems in taxes, currency is accumulated by the non-government sector as financial wealth’ (2011:7) … ‘affordability is never the issue, rather the real debate should be over the proper role of government, how it should use the monetary system to achieve public purpose’ (2011:17). Suggesting that the state should openly reclaim its money-creation power, will almost inevitably be met by the assertion that the issue of debt free public currency risks inflation. This ignores the monetary role of taxation; as Galbraith has pointed out, fiscal policy can be used to manage excess demand as well as managing falling demand (1975:306-7). If more money is issued than can be absorbed by the level of goods and services in the economy, taxation can be used to retrieve that money. Critics of states ‘printing money’ tend to ignore the inflationary pressures of the floods of bank issued debt that have led to a series of asset-price booms. Good and bad management of money can occur in both state-based and bank-based money creation. Securitising public expenditure as debt, while not fiscally necessary, does have monetary and financial uses. Its monetary role is similar to that of taxation, to withdraw money from the economy. Its financial role is as an investment. In times of 8 crisis, public debt, far from being a problem, is an essential asset for the financial sector. Following the recent crisis, investors were willing to embrace negative real interest rates for the safe haven of sovereign debt. Even bailout countries such as Portugal were able to return to the commercial markets at a reasonable rate of interest relatively quickly. Pension funds and other financial institutions rely heavily on public debt. However, selling public deficits as debt is socially unjust, as repayment of that debt falls on the public while the investments are mainly a source of benefit to the already wealthy who can directly or indirectly ‘buy’ the debt. A fairer way is to remove money through progressive taxation, particularly of capital, as Piketty suggests (2014). The choice between additional taxation or increasing national debt is highly ideological and goes to the heart of modern public finance. In the run up to the crisis there was no sense of the public sector as a legitimate creator of money or of a public money circuit. Only the commercial circuit of money figured in the dominant ‘handbag economics’. “
Democratisation of Money
Commentators from the left and right have largely ignored the democratic potential of money. Instead they focus on the ‘real economy’ which is generally taken to be the capitalist productive sector. Money is seen as an epiphenomenon. What money circuit theory points out is the importance of the credit circuit in stimulating the productive process. Obtaining credit gives the borrower access to goods and resources that they have not yet ‘earned’. If this is true of the commercial money circuit it is equally true of the public money circuit. The creation and circulation of public money give people access collectively to goods and services. In Marxist terms it stimulates use value rather than exchange value or more correctly it stimulates monetary exchange for use rather than monetary exchange for profit. As argued earlier, money does not represent a value in itself, it is a representation of entitlement (access to goods, services or resources) matched by an obligation on others to accept it in payment. This is true for both the public and commercial circuits of money. In the same way that the commercial money circuit enables a commercial economy, the public money circuit can enable a public economy. There is no need to invent the public circuit – it already exists. Public money free of debt demonstrably exists, as when the central bank creates money it owes it to no-one. Any decision to then issue this money as a loan is purely ideological. There is also a public money circuit of expenditure and taxation where the need for surplus public expenditure is demonstrated by the fact that most states run deficits. Conventional economics also recognises the anomalies of currency monetary theories with the epicycle–like notions of fractional reserve banking and real versus credit money. To democratise money it is necessary to expose the illogical and ideological nature of conventional thought. The public sector is not monetarily dependent on the private sector, it is the private sector that is dependent upon public money. Money is not a political irrelevance. It is also not commercial in essence. Money can be the servant, not the enemy of radical democracy. Historically its origins lie in social convention and public authority as well as commercial credit. Democratised 13 money provides the potential to organise complex, large scale economies on a collective basis without undue bureaucracy or top down planning. In my forthcoming book I discuss in detail how democratised provisioning through the use of publicly created money could be achieved (Mellor in press). As Felix Martin argues: ‘ money is the ultimate technology for the decentralised organisation of society…only democratic politics provides the sensitivity to current conditions and the legitimacy … that is necessary for money to work sustainably’(2014:272). Deficit is therefore not a deficit – it is surplus expenditure. In the absence of handbag economics, more money can be circulated than will be reclaimed. This money would be free of debt or obligation and therefore be free to circulate.
Most importantly for capitalist economies, it could provide unencumbered money to pay debts and enable the extraction of profit. Rather than privatised money being ‘made’ in the market and then (grudgingly) extracted as tax to fund the public sector, a public economy would work the other way around. Public money would be created free of debt and used to enable democratically determined public services and policies. A monetary decision would be made as to how much should remain in circulation and suitable taxes then imposed (on environmental and social principles). The private sector would then earn the remaining money in circulation by providing goods and services on a commercial basis. The commercial provision of money as debt would cease to create new public currency and would revert to what orthodoxy says banks do – act as a conduit between savers and borrowers.”
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